6 Pros and Cons of Debt Settlement

Jul 11, 2015

Many households today are struggling with debt. From student loans to medical bills to credit cards, the presence of debt can be destructive to the entire family. That’s why the offer of a debt settlement can be very attractive to those who are struggling. Should you take the settlement if it is offered? Or should you look for other options? Here are the pros and cons of debt settlement to think about before making a final decision.

The Pros of Debt Settlement

The primary advantage is that a settlement eliminates your debt once and for all. You have a legally binding agreement that says you’ll pay a certain amount to clear the debt off your records. This means you could pay pennies on the dollar for the debt. There are these additional advantages to consider as well.

1. It is better than a bankruptcy.
A debt settlement is like a bankruptcy in that it clears away a debt for good. The difference is that a bankruptcy can be damaging to your credit for up to 10 years. The debt settlement will mark your account as “Settled in Full” instead of “Paid in Full,” which knocks off a few points, but isn’t nearly as bad as the alternative. Settlements stay on a credit report for 7 years.

2. It offers lower monthly payments.
Some debt settlement offers are based on a lump sum payment. Others are based on lower monthly payments that are designed to get you out of debt faster. Even if you take the monthly payment option because you can’t afford a lump sum amount, it’s still possible to pay half the debt owed or less instead of the full amount. You get to save time because the debts are consolidated as long as the program payments are being made.

3. It frees up additional income.
If you’ve got an account that has been settled, then you’ve got more money that can be used for other debts. It’s called the snowball effect. You can continue putting more money toward the debts you have so that eventually all of your debt can be wiped out. For a debt settlement program, it usually means there is just one lower monthly payment made and the extra income can then be used to pay down other balances.

The Cons of Debt Settlement

The primary disadvantage of a debt settlement is that the forgiven debt is counted as income. There are some exceptions to this rule, usually when it comes to a debt settlement offer for a mortgage, but it applies most of the time. If you have a $6,000 credit card debt you settle for $2,000, then that extra $4k becomes reportable income on that year’s tax returns. Here are the other disadvantages.

1. Late payments are still registered until the account is cleared.
Even if your lender has directly agreed to a lower monthly payment, because the amount is lower than what the initial contract stipulated, there is a good chance that each month a late payment will be registered on your credit report. Any late payment can be damaging, which means debt settlements are typically best for credit situations that are already poor.

2. Middleman companies make it difficult to gather information.
The best course of action for a debt settlement is to deal with a company directly. If a settlement agency is used, there is no real way to know how much of your monthly payments are going to remove debt and how much is a fee charged for services rendered. Even if you get this information, you really have no guarantee that it is accurate.

3. Scams are everywhere.
Many debt settlement agencies require people to send secured funds in order to pay down their debts. The problem with this is that secured funds can be cashed easily and you’ve got no control on how that money is being spent. For all you know, it could be going to pay for an executive’s mint juleps in the tropics instead of your debt.

The pros and cons of debt settlement prove that it is not the right system of financial management for everyone. Some debts can actually be good debts if their interest rates are low and their balances kept current. Look at all of your options, manage your debt proactively, and take advantage of a debt settlement if it makes sense. In doing so, you could be taking the first steps to a stronger financial future.

After being physically and mentally disabled by a brain tumor, Brandon overcame the odds to regain his health to help his pregnant wife in her fight against stage 3 breast cancer. A couple of years later he launched his blog. Today over 1 million business owners read his blog every month. Read Brandon's inspirational comeback story here.